Insurance and stability the reform of insurance regulation

Zurich Financial Services Group Insurance and stability the reform of insurance regulation Here to help your world. 2 Executive summary The design of insurance regulation appropriate to the enhancement of financial stability requires a profound understanding of the role of insurance in the financial system and economy. Insurance contributes to economic welfare, growth and stability by pooling the risks of individual policyholders, providing them with protection against the financial consequences of various perils. Regulation should be designed so as not to hamper this basic function of insurance. The way in which the failure of an insurer affects the financial system and economy differs fundamentally from a banking failure. Unlike banks, insurers do not take deposits and do not play a role in the monetary or payment systems. Redemption, funding or credit risk leading to problems for other financial institutions are not issues when a classic insurer fails. Classic insurers therefore do not present a systemic risk and, as a consequence, are neither ‘too big’ nor ‘too interconnected to fail’. A failing classic insurer can be unwound in an orderly manner whilst protecting the claims of its policyholders. Indeed in many jurisdictions (e.g. in the US), small policyholders are protected by an insurance guarantee fund. Thus government financial support to prevent failure, for instance by injecting capital or liquidity, is not required. The resilience of the sector could be increased by measures to reduce the potential mismatch between an insurer’s volatile assets, which depend on financial market conditions, and inflexible liabilities, which are based on the statistical properties of the insured risks. Insurers that engage in non-classic activities, such as insuring financial risk, for example by selling credit default swaps, however, may become a threat to the stability of the financial system. This can be avoided by applying adequate risk-based capital requirements to all the risks of an insurance group (both classic insurance risks and financial risks). To enforce such comprehensive risk-based capital requirements, insurance groups must be subject to group-wide supervision, as foreseen by the European Union’s Solvency II directive for example. On the global level, supervisory colleges are fundamental to ensure effective cooperation among national authorities in the supervision of internationally active insurance groups. We therefore propose reforms to insurance regulation based on three elements: the comprehensive, group-wide supervision of all risks; strengthening the resilience of the industry against extreme asset price fluctuations by enhancing the responsiveness of regulation and better matching insurers’ volatile assets and contractually fixed liabilities; and facilitating an orderly unwinding of the business in the event of failure whilst protecting small policyholders. No case can be made, however, for extending the scope of banking regulation to insurance for purposes of financial stability. To do so could reduce the efficiency of risk pooling by insurers, thereby constraining their ability to promote economic welfare, growth and stability and increasing the cost to consumers. 3 Authors Marian Bell and Benno Keller Marian Bell is a london-based economics consultant and member of Zurich Financial Services’ International Advisory Council. From 2002-2005, Ms Bell was an external member of the Monetary Policy Committee of the Bank of England. Benno Keller is Head of Policy Development of Zurich and Farmers Financial Services based in the US. From 2006-2007, Mr. Keller was Head of Government and Industry Affairs of Switzerland for Zurich. This paper has greatly benefited from helpful comments by André Burgstaller, Peter Buomberger, Axel Lehmann, Jason Schupp and Roy Suter. This is the fifth paper in the Zurich Government and Industry Affairs thought leadership series. Any opinions or viewpoints that are expressed herein are directly from the authors and do not necessarily represent the position of Zurich Financial Services Group. 4 Contents Introduction 6 1. Insurance and the causes of systemic financial crisis 7 2. Insurance and financial contagion 8 Redemption risk Funding risk Credit risk Market risk Counterparty risk 3. Insurance and economic crisis 14 4. Strengthening financial stability 17 Strengthening macro-prudential regulation Identifying systemically important institutions Establishment of a new resolution mechanism for large complex financial institutions Reform of functional micro-prudential regulation 5. Proposals for the reform of insurance regulation 24 Comprehensive and coordinated prudential regulation of insurance groups Strengthen the responsiveness of regulation and resilience of insurers Protect policyholders, not insurance companies Conclusions 26 5 ... - tailieumienphi.vn